Markets

This is one of the longest economic growth cycle in history and the anniversary of the Lehman brothers’ collapse last week, reignited discussions about whether the economic expansion is coming to an end. The discussion is important as the chart above illustrates the correlation between the S&P500 equity index and Retail and food service sales which is the heaviest component of GDP in the US. To be more specific, the correlation between the two data series over the indicated period is 98%, implying that as retail sales grows, so does the equity index. However, volatility is an undeniable feature of markets and the dip in the red line in 2014 – 2015 is a good illustration of this point: during this period, oil prices dipped on account of a supply glut but more importantly, year on year comparison of growth figures plateaued because the base effects of the previous years were steeper. The diversion with retail sales during this period was transitory as the index regained ground again.

So how do we determine whether a cycle is ending or whether the equity index is just suffering a dip when it happens? One method is to analyse measures of demand over multiple cycles to determine the time horizons between the point they peak and the start of a recession. A number of such data points indicate that while growth may be below the highs of previous cycles, there is not yet evidence which is supportive of a bear market for another 12 month excluding a black Swan event. On the contrary, analysts’ forecast from Factset are for earnings to grow double digit next year.

The preliminary estimates of Purchasing Managers’ Index - Manufacturing which has a high correlation to GDP growth will be released this Friday and should reinforce the view that the dip which happened in Europe since the start of the year is fading. This is another positive sign for risk assets.